How to Invest Like a Roman General, Part Two - Using Your Army Mix to Its Fullest Potential
Roman Generals had to command a variety of troops.
As I discussed previously, the iron Discipline and Community that the legionnaires felt while serving in the legion was the backbone of the Roman army.
However, while the legionnaires (infantry and heavy infantry) were the core of the legion, infantry alone cannot win wars.
As you can see from here, there were many different types of troops in the Roman army, particularly before the empire.
Each unit had a part to play in the overall battle, and a skilled general will be able to utilise each unit in the place where it could maximise its potential and minimise losses. Not all generals could do this well, though...
Having many choices is good, but only if you know how to use them.
Knowing each unit and how it interacts with others in battle is key.
In battle, not only is it important to have a variety of units at your command - it is equally important to know how to use those units.
First, let's address the need for variety.
In the Roman army, this variety enabled the Roman general to command effectively, and to respond fluidly to the enemy's attacks. For instance, artillery and the ranged units could soften the enemy before the main legion charged in, while being supported on the flanks by the cavalry.
A lack of variety had devastating effects. In one famous battle that Rome lost (the Battle of Carrhae), the general then (Crassus) had mostly heavy infantry, and while tactics and backstabbing played a role, the infantry could not match up to the speed and firepower of the Parthian horse archers.
The lackluster amount of cavalry that Crassus brought was not enough to mount a counterattack, and his army was defeated in one of the more spectacular losses of Roman warfare.
Thus, knowing how to use your units is important too.
There is no point in having a spectacular army if you don't understand which units are complementary to each other, and how to respond effectively to enemy movements.
For instance, you will not try to stop a charge of heavy cavalry by flooding infantry in! While the charge may be stopped eventually, you would have lost so much infantry that you would have lost anyway (see Crassus above).
Another battle where this can be seen is when Rome first fought the Carthaginian general, Hannibal Barca, during the Second Punic War. The Roman generals tried to use their legions to stop the Carthaginian's war elephants, with miserable results. The war elephants literally trampled them and punched large enough holes for the Carthaginian infantry to break the lines of the legionnaires.
Thus, using the appropriate units at the appropriate times for the appropriate purpose is important. So, these two concepts work hand-in-hand. You must have have access to a variety of units, and know how to use those units in certain situations either to counter an enemy attack, or to complement and follow up on your own.
How do these impact your investment strategy?
Well, diversification, of course.
Many people talk about diversification as the be-all and end-all to investing.
But first, what is diversification?
Well, diversification, by definition, is owning different categories of assets that do not correlate with each other. The best case is if the correlation coefficient of all your asset classes with each other is ZERO - that will be 'perfect' diversification.
However, that does not exist today. Many investors who are building a portfolio make this mistake - just because they own assets that invest in a variety of asset classes (e.g. ETFs or Mutual Funds / Unit Trusts), they think they are diversified. In fact, the correlation of many of these asset classes may be closer to ONE instead - so even though you own many different asset classes, you are not actually diversified.
One common example is how an ETF tracking the S&P 500 is bandied about like it gives you all the diversification you need. That is a dangerous half-truth.
Because the S&P 500 tracks, by market capitalisation, some of the top 500 companies in the USA. Thus, you are only diversified when it comes to US Large-Cap stocks. But, if you wanted other segments of the market like small to mid cap, or other geographies, then the S&P 500 alone doesn't cut it. You need to add in some other ETFs that track other indices e.g. the MSCI indices or the iShares ETF series.
So the ground rule is - if you want to diversify, make sure that you are really diversified.
The beauty of diversification is it's about as close as you can get to a free lunch in investing.— Barry Ritholtz
But there is another question - should you even diversify in the first place?
Many personal finance authors and even some investment advisors will tell you to diversify, and just stop there. While that is generally accepted advice, again, you must know how to use this tactic to be able to reap the best rewards from it.
Consider the alternate viewpoint, succinctly captured by Warren Buffet:
Diversification is protection against ignorance. It makes little sense if you know what you are doing.— Warren Buffet
Now, some people will take that quote out of context and rubbish the whole idea of diversification. That's not a good idea.
This quote actually makes a lot of sense for a personal investor, i.e. someone doing it with their own money and not at a professional level.
Because of wilful ignorance.
Now I can imagine the eye-rolling taking place behind the screen. After all, if you are putting in effort to build a personal portfolio, you will take pains to avoid being ignorant. So, how can wilful ignorance even be a consideration for you?
Well, it boils down to this concept that CFA Level III defines as 'satisfising' (satisfy + optimise). This means that as personal investors, it is likely that we do just enough research to satisfy ourselves that our investment decision is correct, but we do not optimise, because the time and effort needed to optimise is not worth the marginal returns that an optimised portfolio will generate versus a 'satisfised' portfolio.
Additionally, research has shown that asset allocation is the factor that impacts the returns of a long-term portfolio the most. This then adds to the 'wilful ignorance' idea, because if I am just looking at my portfolio from an asset allocation perspective, I don't really need to agonise over which particular stock to add to my portfolio.
Instead, I can just 'satisfice' myself by selecting the broad market indicies that I want exposure to, and just buy an ETF that tracks that index instead of trying to identify the best stock in that pool. It is not that I don't want to optimise - if I could, I would. But the harsh reality is that I don't have the time or experience to research stocks like the professionals.
So, since I choose to be wilfully ignorant, diversification helps.
When diversifying your portfolio, re-balancing plays an important role.
Now, we cannot talk about diversification without re-balancing.
The whole point of diversification is to ensure that you have certain percentages of asset classes in your portfolio. But, if you don't regularly monitor and re-balance your portfolio, the chances of your initial asset allocation drifting away from your desired mix is very high.
That will leave you with a portfolio that doesn't match your desired risk and return profile!
An additional benefit to re-balancing is that it forces you to buy low and sell high. This is because you will have to buy more of the underperforming asset and sell some of the outperforming asset to obtain your original portfolio allocation.
Again, you must know some key principles of re-balancing to be able to use it effectively. Re-balancing works best in volatile markets, because you will get to lock in gains every time you re-balance. There are only two situations where re-balancing underperforms:
1. If the markets all shoot straight up. Then, you would have outperformed by buying in at the start and not touching the portfolio at all; or
2. If the markets plunge to zero. Then, you would have been better off just holding cash!
So since we cannot predict where the market will go but we know that the market moves up and down over the long term (with the general trend being upwards), re-balancing will help you lock-in the gains and grow your portfolio over a long period of time.
This discipline of re-balancing is one reason why I am slowly exploring robo-advisors instead of relying on my own research, because I realise that I didn't re-balance my portfolio at all, but instead just left it there (and I didn't manage to re-invest my dividends effectively either).
If you also struggle with this discipline, you can also consider using a robo-advisor. I currently am testing Stashaway (and if you use my referral link, we both get discounts off the first $10k invested with them), but the concept is the same. Unless you can re-balance your portfolio regularly (and have sufficient capital so that transaction costs do not erode your returns), I would suggest looking for someone that can re-balance your portfolio for you (after all, there are so many different robo-advisors out there now).
Here comes the call to arms!
There are also things you can put into action today, to hone your skills to invest like a Roman General.
1. Review your portfolio and your lifestyle and decide whether you want to diversify, or have the time, money, and risk appetite to make concentrated bets.
2. If you decide to diversify, also seek out a way to re-balance regularly.
3. If you decide to make concentrated bets, all the best! It's not an easy road. I hope to go down this road eventually, but I am unable to do so at this time.
4. Need to regroup? Perform a tactical withdrawal and access the first part here.
If you'd like to find out more about Hannibal, I would recommend this series.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2019 Russell